Robo advisers might not be a term those stuck with it like, but it is not doing them any harm. Online investment services (a description many prefer) that create and manage model investment portfolios tailored to clients’ risk appetites – and usually constructed with exchange-traded funds – saw strong growth in the US last year.

Source: Alamy

Wealthfront, the biggest of the new service providers that use computers to construct and manage portfolios for individuals with little or no human intervention, launched in December 2011. It started last year with $500 million in assets and closed it with over $1.7 billion. Rival firm Betterment now has almost $1.2 billion. A survey by consultant Corporate Insight of the 11 leading robo advisers in the US estimates that they managed total assets of $19 billion by December – up 65% from April. Another study, published in September by Swiss-based MyPrivateBanking Research, forecast the industry’s global assets would increase to $255 billion in the next five years.

These sums are still small in the context of overall US investments through advisers and brokers, with big advisory firms (managing more than $500 million) controlling $5 trillion in assets in the US, according to a report by Cerulli Associates last year.

Samuel Lee, ETF strategist for Morningstar, is not convinced that robo advisers offer investors much more than traditional ETF portfolios that have long been offered online by the likes of asset manager Vanguard.

He said: “It is really a repackaging of old things, but doing it in a more user-friendly manner.” However, robo advisers are becoming more prevalent, he added. “That is not up for dispute; they are gathering assets at a fairly quick pace.”

Adam Nash, Wealthfront’s chief executive and president, said much of the scepticism of the services had evaporated in light of the growth, which he expects to continue.

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He added: “It is hard to argue with the numbers. Charles Schwab [the US retail broker] now has a $2.5 trillion business and it took them six years to get to $1 billion. It also took them six years to get from $1 billion to $10 billion and $10 billion to $100 billion.”

This quarter, Charles Schwab too is expected to launch a robo service, called Schwab Intelligent Portfolios. Vanguard’s Personal Advisor Services, meanwhile, had $4.2 billion in assets at the end of November, although the company said it was not a robo adviser since it still involved a personal (human) adviser.

That trend is likely to continue, with white-labelling services making it easier for small advisers to move to the model. Betterment Institutional, which is a collaboration between the robo adviser and Fidelity Wealth Management, for example, provides a digital adviser platform that traditional investment advisers can brand to deliver their own robo adviser service.

Rick Ferri, founder of Portfolio Solutions, an adviser and index investing specialist with $1.3 billion of client assets, is planning to use a white-labelled solution to enable it to service those with less money to invest.

He said: “Our minimum portfolio size is $500,000 and, for those who don’t have that much money, this will give them the same portfolios and the same results, for the same costs, so it’s a good solution for them.”

This is typical, according to Tom Kimberly, chief executive of Upside, a technology start-up that also provides a robo adviser white-labelling solution. A key benefit of robo advice is the ability to service smaller clients cost effectively. Wealthfront’s minimum investment is $5,000; Betterment has no minimum.

Kimberly said: “Looking five to 10 years down the line, if an investment provider doesn’t have some component of his practice that is at least hybrid, I think he will be drastically behind the times.”

If so, ETFs are likely to benefit. Many robo advisers, including Wealthfront, Betterment and Charles Schwab’s new service, use ETFs to build the model portfolios.

Some of the money would have gone into ETFs anyway, but it will also attract new investors, according to Kevin Quigg, global head of ETF sales strategy at State Street Global Advisors. It should also boost awareness of ETFs, he added. “Robo advisers are using ETFs as a core part of their implementation and as such they have a stake in making sure people are really well versed in how ETFs work.”

Challenges ahead

There are still challenges ahead, however. For a start, robo advisers represent a very small part of the market, with assets of $19 billion, compared with a US exchange-traded product industry that broke the $2 trillion mark in assets under management in December, according to consultant ETFGI.

Asked about the significance of robo advisers, BlackRock, the largest ETF provider, said it was too early to comment.
Growth may also be more challenging outside the US. According to the MyPrivateBanking Research study last year, 83% of robo adviser assets are held in the US. There are European robo advisers, such as Nutmeg in the UK, moneyfarm.com in Italy and Vaamo in Germany. However, they are fewer and might, according to Dan Egan, Betterment’s director of investing, find it harder to achieve the scale necessary for a profitable business due to smaller markets.

He said: “It is a scale game because the marginal cost of each new client is very near zero.”

Furthermore, regulation remains a concern. Christopher Aldous, managing director of index investment specialists Charles Stanley Pan Asset, said his
firm was keen to launch an online service in the UK. However, it wants more clarity from the Financial Conduct Authority, the UK regulator, over the distinction between discretionary asset management (the service robo advisers are offering in the UK) and financial advice, which is tightly regulated to ensure advice is appropriate to clients’ individual circumstances.

Aldous said: “The problem is that if you put information in through a website and it spits out what it says is the right outcome or portfolio for you, you have by definition given some sort of advice.”

The FCA is due to publish the results of its consultation on the issue this month, which Aldous hopes will bring some clarity, but he worries it may not. “I fear that they may not be very clear,” he said.

This article first appeared in the print edition of Financial News dated January 19, 2015